Top 10 Bankruptcy Truths for Creditors to Know

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Much of the bankruptcy chatter arising from the pandemic world in which we find ourselves is now focusing on the cascade of new bankruptcy cases that are predicted to arrive soon. We have already seen the effects of closed stores and no foot traffic on some of the big names in retail (J.C. Penney, J. Crew, Neiman Marcus, Pier 1, etc.), but many consumer cases are sure to follow, the result of the staggering number of layoffs and lost jobs that the pandemic has caused. Now seems an appropriate time to remind creditors of certain bankruptcy principles to keep in mind.

  1. The automatic stay is, well, automatic.
    1. The stay goes into effect from the exact moment the petition is filed.
    2. The stay is automatic. No order is necessary to trigger it.
    3. Generally, any collection action taken after the filing of the case is a violation of the automatic stay.
    4. As a result, heed all notices that a bankruptcy petition has been filed, and check PACER to confirm a filing.
    5. Even if you have not received notice, checking PACER for a filing before commencing or taking a significant action (demand letter, lawsuit, foreclosure, repossession, etc.) is prudent.
  2. The automatic stay is broad and probably covers whatever the creditor has already done or wants to do soon.
    1. The automatic stay is the great equalizer: it gives the debtor relief and levels the playing field among the creditors. The "race to the courthouse" ends.
    2. As a result, the automatic stay is intentionally broad and applies to all actions to collect debts, perfect liens, attach property, repossess property, setoff accounts, etc.
    3. The exceptions listed in the statute are narrow but important.
    4. Outside of those exceptions, a creditor must state grounds and obtain an order of the bankruptcy court relieving it from the automatic stay.
  3. Know whether, when, and where a proof of claim has to be filed, and file it on time and in the right place.
    1. Read the initial bankruptcy notice that comes a few days after the case is filed. It contains important information:
      1. The date of the filing;
      2. The type (chapter) of bankruptcy case;
      3. The date, time, and place of the 341 creditors’ meeting;
      4. The deadline for objecting to the debtor’s discharge or to the dischargeability of the debtor’s obligations to the credit union (see #7 below); and
      5. A notice about filing a proof of claim.
    2. The type of case will govern when, and even whether, a claim is filed.
    3. The type of debt, and whether it is secured by a primary residence, will govern what documentation or supplements should be filed with a proof of claim form.
  4. Receiving a preference payment from a future bankruptcy debtor is not illegal (or immoral). Always take the money; worry about a preference claim later.
    1. Generally speaking, a preference is a payment or transfer of the bankruptcy debtor's property (including the giving of a lien or deed of trust) made with respect to an existing debt within 90 days before a bankruptcy filing.
    2. Even if you know the debtor intends to file for bankruptcy, take the payment. Defenses are often available, and cases often settle for less than 100 percent.
  5. Bankruptcy cases come in a variety of forms and circumstances.
    1. Sometimes, the cases compel quick and early compromise because there are few spoils available for the victor.
    2. But, other times, litigation can be useful.
    3. Early and careful analysis of the bankruptcy papers, the issues, the value of property or assets impacted by those issues, and the merits and likelihood of recovering the value of those assets is therefore critical to an early and full understanding of the alternatives in each bankruptcy case.
  6. A discharge ends the individual debtor’s personal liability, but the creditor’s lien is forever (except when it is not).
    1. For the individual debtor (excluding entities), the goal is a fresh start, resulting from the discharge of the debtor’s personal liability for all dischargeable debts.
    2. As a result, the creditor cannot take any action against the debtor to collect a discharged debt as the personal liability of the debtor.
    3. Absent affirmative action by a debtor or trustee, all liens pass through the bankruptcy unaffected. Therefore, a debtor seeking to retain property affected by liens can and will often still pay discharged debts voluntarily.
    4. The debtor who wants to keep the collateral must keep paying for it, either through a reaffirmation of a loan or continued payments.
  7. Sometimes, creditors can object to the discharge of their debts; but they must act quickly.
    1. Section 523 of the Bankruptcy Code provides a litany of debts that are not dischargeable (even if the debtor gets a general discharge in the case), but, in most cases, a creditor must affirmatively object to the discharge of its debt by filing an adversary proceeding (litigation within the bankruptcy case).
    2. Many of the grounds for such objection stem from fraud or dishonesty on the part of the debtor.
    3. The deadline for the filing objections to the discharge of a particular debt is about 90 days after the creditors' meeting and will be listed in the initial notice of the filing of the bankruptcy case. If the complaint is not filed within the time period established (which can be extended by the court), the debt is discharged.
    4. NOTE: There is no bankruptcy discharge for a Chapter 7 debtor that is not an individual (e.g., corporation, limited liability company, partnership, etc.). Chapter 11 non-individual debtors can obtain a discharge if provided for in a plan and approved by the court.
  8. The creditor’s contract terms can usually be modified in a Chapter 11 or Chapter 13 case, unless the only lien is on the debtor’s principal residence.
    1. One of the essential elements of reorganization cases under Chapters 11 and 13 is the debtor’s right to modify the terms of the loan with the creditor: to adjust the interest rate, the term, the payment amount, and/or the principal amount.
    2. These proposed modifications are subject to court approval during the plan confirmation process and cannot be approved over the creditor’s objection, unless certain requirements and standards are met.
    3. In Chapter 13 cases and individual Chapter 11 cases (outside of some limited circumstances in a small business debtor Subchapter V case), the terms of a home mortgage loan cannot be modified without the consent of the lender, if the only collateral for the loan is the debtor's principal residence.
  9. Focus quickly on the issues of the reaffirmation of secured claims.
    1. The reaffirmation agreement must be signed by the debtor and the lender and filed with the court within 60 days after the first date set for the creditors’ meeting. The agreement must be on the approved form and must include copies of the note and security documents establishing the lien on the collateral.
    2. For personal property collateral (e.g., car loans), the failure to comply with the requirements could result in the issuance of an order finding that the debtor has complied with all requirements under the statute and that the lender cannot repossess the personal property if the debtor continues the regular payments.
    3. In the Fourth Circuit, the debtor gets a “ride through” on all real property loans, meaning that if the loan is current at the time the petition is filed, the debtor can continue to “pay and stay.” Reaffirmations of real estate loans are approved only if the terms of the loans are being changed to the debtor’s benefit.
  10. Think twice before participating in an involuntary bankruptcy case.
    1. Most bankruptcy cases are started as voluntary cases by debtors seeking the relief provided by the Bankruptcy Code. However, it is possible for creditors to begin a bankruptcy case as an involuntary case.
    2. Generally speaking, three creditors owed an aggregate of at least $16,750 must participate in the filing of an involuntary case. Therefore, one creditor may be approached by another creditor and be asked to participate as a petitioning creditor.
    3. But, be very careful when considering whether to join.
      1. If the debtor convinces the Court to dismiss the involuntary petition, the debtor will be awarded attorneys' fees and possibly damages to be paid by the petitioning creditors.
      2. Sometimes, the lead petitioning creditor has a personal vendetta that increases the likelihood of dismissal of an involuntary petition.
      3. Try to determine whether there is something in the case that is likely to benefit the creditors, usually evidence the debtor has made large preferential payments to other creditors or fraudulent transfers to other parties, particularly owners, officers, or other insiders.
  11. (BONUS) Legal fees spent early are more productive than legal fees spent late.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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